Private equity investing focused on climate change may well become the second largest sector after technology, which today accounts for 37 percent of all private equity investments.
This is not a new sector, but rather the evolution of the historically highly challenged cleantech and renewable energy infrastructure sectors. At Partners Capital, we refer to this as the “climate impact” sector, which spans early-stage venture investment through to buyouts of well-established businesses focused on the reduction of greenhouse gas emissions in the energy, mobility, industrial, food and agriculture, smart building and recycling sectors.
Supporting the climate impact sector is a megatrend of vast proportions, with the largest tailwind of capital flowing into it that we have ever seen. The Glasgow Financial Alliance for Net-Zero (GFANZ) has brought together more than $130 trillion of assets committed to net-zero carbon emissions by 2050 or sooner, representing circa 80 percent of global GDP. This represents a significant challenge but also an unprecedented opportunity.
Muddying the private equity landscape around climate change is the fact that all private equity investors are in the process of integrating environmental impact risks and opportunities into their investment processes as all private and public companies will be forced to better manage climate-related risks and opportunities. This upheaval is akin to what PE firms went through in the past 15 years with digital transformation; PE firms that did not invest in their own digital transformation capabilities fell behind their peers who did. The same will be true of firms and their environmental impact integration.
While all private equity firms work to advance their environmental impact integration capabilities, true climate impact investors will distinguish themselves by focusing on those businesses at the epicentre of climate change. Akin to what we have seen in other sectors such as technology, healthcare, consumer, industrial and financial services, deep expertise and specialist knowledge will outperform generalist approaches.
In venture, climate impact investors will focus on early to late-stage innovators in carbon capture, electrofuels, nuclear fusion, electricity storage, zero-carbon plastics and plant-based meat and dairy, etc. In growth equity and buyouts, this will include renewable energy integration, grid management software, smart building energy management, fleet energy management, recycling, alternative proteins, etc. Mirroring the approach of other specialist sector-focused PE firms, successful climate impact investors will build barriers around their businesses through their deep insights into these micro-sectors of the climate impact sector. Entrepreneurs and buyout company management teams want to work with the most value-added investors who can help them navigate through all of the technological, regulatory and societal challenges facing businesses at the crossroads of climate change.
Climate impact is not a new PE sector, but rather one that has stumbled and taken important learnings from past failings into investment strategies today. Between 2005 and 2009, a flood of capital was deployed into cleantech, 30 percent of which found its way into renewable power manufacturing which lost billions of dollars for investors. The rapid rise in Chinese solar panel production, resulting in an 80 percent reduction in the cost of solar, the emergence of cheap natural gas and fickle regulators saw many of these early firms and funds suffering some of the worst losses in the 50-year history of the private equity asset class.
While the opportunity is huge, the biggest challenge today is finding successful veteran private investors in the climate impact business sectors listed above. Few venture capital firms survived “cleantech 1.0” and those that did, remain wary of going back in. We see a rising number of traditional oil and gas private equity managers pivoting to renewables and cleantech but who are yet to prove themselves. Finally, we have observed an accelerating trend of generalist private equity managers launching climate impact funds, employing generalist PE team members who are learning as they go.
Our approach at Partners Capital is not so much to focus on the firm, but on the individuals who have the longest experience, deepest insights and strongest investment track record in these specific industries.
There are many unanswered questions that could surprise investors again including the future of hydrogen, nuclear fusion and carbon capture, and myriad regulatory matters including carbon taxation, carbon credits, subsidies, etc. The list of investors who have true insight into the answers to these questions is a very short one. In our many decades of investing in private equity, we have never seen this scale of opportunity with such a scarcity of veteran talent to exploit it. So, the race is on to build those capabilities.
Stan Miranda, co-founder and chairman of Partners Capital, an outsourced investment office for institutional and private clients.